Times of trouble, but cliff of doom a mirage

There's no real doubt in the markets that America is good for the IOUs it has issued. Photo: AFP

I WAS in the air headed east over the Pacific Ocean when Barack Obama won a second term, and have just returned from the US, where I saw BHP Billiton's new shale oil, liquids and gas play and talked to Wall Street economists, bankers and investors about America's prospects, including the so-called fiscal cliff - a blend of automatic spending cuts and de facto tax increases in the new year that some say could push the US deep into recession. I have returned convinced that the shale boom is a global game-changer, and that the fiscal cliff is a beat-up.

It's huge, on paper. Scheduled cuts to payroll tax ($US120 billion), government spending ($US110 billion), the expiration of temporary tax cuts initiated by the spendthrift Bush administration ($US180 billion) and the expiry of other ''crisis cushions'' including extended unemployment benefits have the potential to rip $US720 billion out of the US economy next year, pulling gross domestic product down by a gob-smacking 4.6 percentage points. Growth would be about minus 2.5 per cent in 2013 in other words if the US economy goes over the fiscal cliff and stays there for a year.

It won't, of course. A deal of some kind will be struck, most probably what Morgan Stanley's chief US economist, Vincent Reinhart, recently described as ''a patch with a promise, followed by a plan'' - and the deadline is not the end of this year before the cliff materialises but somewhere around mid-February, when America's expanded government debt ceiling of $16.4 trillion is reached. The ceiling needs to be lifted again, and a new debt deal will be part of the way that it is achieved.

The politics will be fraught. Both sides might go over the cliff deliberately in fact, in the belief that a deal will be easier to construct once the automatic cuts have kicked in. The expiration of the Bush tax cuts, for example, would be a de facto tax increase that creates room for the Democrats to retain most of the new tax revenue but also finance tax cuts for middle-income Americans. The Republicans could finesse automatic spending cuts in similar fashion, retaining most but deploying some in the form of targeted spending initiatives.

The markets will be agog while it all plays out. The cliff that is approaching was born out of the standoff in Washington in mid-2011 when the debt ceiling was last approached (it was $US14.3 trillion then), and the failure of lawmakers to agree on a long-term plan pushed sharemarkets down and prompted Standard and Poor's to lower its US government debt credit rating from triple A to double A-plus.

Signs of serious discord during the new negotiations would produce similar selling pressure, and there is absolutely no doubt that America does have to pull its debt load down. That involves an attack on unfunded social security and health liabilities that total $US53 trillion, and while the bill is payable over many years, as baby boomers retire the payment horizon is shortening. Almost $US7 trillion of America's existing $US16 trillion-plus debt load is tied to entitlements, with Medicare benefits at the top of the list.

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Total US Medicare liabilities more than doubled from just over $US9 trillion to $US24.7 trillion between 2000 and 2011, and now account for about 15 per cent of US GDP. A serious attack on America's deficit and debt burden can't occur until that Medicare bill is cut, but that will involve a reduction in service levels that Washington won't be discussing in these latest talks.

Wall Street will complain, but eventually wear it: remember that when S&P cut America's credit rating in August 2011 after the last debt negotiation debacle investors didn't sell US bonds. They bought them by the bucketload. That tells you that even if Washington ducks again there's no real doubt in the markets that America is good for the the IOUs it has issued.

Shale boom gathers pace

MY TRIP to Texas as a guest of BHP and my subsequent talks in New York with economists, analysts and investment bankers in New York about America's shale oil and gas production boom meanwhile underlined that BHP Billiton got its biggest shale deal in the US right. The growing consensus on Wall Street is also that the US shale boom is a global economic and geopolitical game-changer.

BHP's first purchase of shale gas leases in Arkansas for $US4.6 billion was fully valued at the gas price of the day, and the $US2.84 billion write-down the group announced in August was arithmetically generated as US shale gas production soared, and US gas prices plunged.

The group's subsequent $US15 billion takeover of US group Petrohawk at 65 per cent premium to Petrohawk's market price could produce an asset valuation uplift this financial year that more than compensates for the first write-down.

BHP can still earn returns of more than 20 per cent by developing gas wells in Arkansas, but it is aiming instead to increase production of oil and other liquids that are roughly four times more valuable by 15 per cent in 2012-13 by redirecting the vast bulk of its $US4 billion shale capital expenditure budget to Petrohawk's oil and liquids-rich fields in Texas.

In New York, the big bulge-bracket banks are all doing their sums on the shale boom. One estimate of the value transfer from the rest of the world to the US is already $US900 million a day as US domestic production grows and imports fall. That's an amount equal to 2.2 per cent of raw GDP, but what the US does with the income windfall is the key, as it was here during the commodities boom. To the extent that the new income finances consumption of imports, for example, domestic benefits of the boom will be lower.

The US will certainly benefit from cheap domestic gas that will deliver cost benefits to heavy industries including petrochemical plants and power stations, but the horizontal drilling and rock-fracturing technology that is freeing up shale gas and oil will ultimately generate sweeping global changes.

Shale oil can be commercially exploited at oil prices as low as $US80 a barrel, and as shale oil volumes rise, oil price spikes in response to accelerating growth in demand that work to slow demand again will be much less frequent. Shale oil, in other words, is going to raise the maximum speed limit of the global economy. I will have more about the amazing shale boom and BHP's piece of it in coming columns.